“Fallacies of Monetarism"

Abstract

Fallacies of Monetarism

Modern monetarism is built on threnn fallacious assumptions. The first is that in a capitalist economy, markets operate in a perfect Walrasian manner, with prices being completely flexible and changing immediately in response to any change in the relation of supply and demand. The second is that a credit-money economy (where money consists of certificates of debt, and comes into existence as a result of bank directing) is the same as that of a commodity money economy, where the total amount of gold, silver or oxen outstanding at any one time is exogeneously given. The third assumption is that a change in the “money supply” has a direct influence in the demand for commodities and that the “money supply” is under the control of the Government. The first assumption leads to a denial of the possibility of an inflation occurring as a result of a rise in costs, even in times of deficient demand. It decrees that market responses to changes in the supply/demand relation can take the form of quantity responses and not price responses. The second assumption allows the monetarists to treat the quanitity of paper money (however defined) as exogeneously determined. Once it is recognised that the amount of money in circulation is determined by, and changes with, changes in the public’s demand for money, the empirical proofs produced in support of the quantity theory of money lose their validity. The rise in the money supply is always a consequence of, not a cause of, a rise in incomes and prices. Given a modern banking system with fractional reserve requirements, it could not be otherwise. The failure of ‘monetarist’ Governments (such as those of Mrs. Thatcher and President Reagan) to attain their stated objectives is easily explained once the basic fallacies in their reasoning are understood. In particular, the Thatcher Government has demonstrated (and the chief monetarist, Milton Friedman, admitted) that with the type of monetary and banking institutions that exist, e.g., in England, the Government cannot control the “money supply”.